What If I Owe More Than My House Is Worth to Refinance?

by Barrett Barlowe

Unstable housing markets can put a homeowner upside down on a mortgage.

Piling additional debt onto a mortgage, or taking out the wrong type of loan to begin with, can land a homeowner upside down on his mortgage--owing more than the house is worth. In the housing boom that led up to the housing bust of 2008, home prices rose sharply. Confident in the market, some homeowners took out cash when they refinanced. Others could not resist the lure of easy credit and signed up for homes with little or no down payments.

Who Gets Underwater

Homeowners who make required payments every month, on time, can still get underwater on a mortgage. In a zero- or 5-percent-down mortgage, any downturn in housing prices might quickly turn the loan upside down. Option ARM loans that allow an owner to make very low monthly payments--ostensibly in order to make a mortgage more affordable--can end up putting a homeowner underwater, causing her to sink deeper with every payment. Because the low minimum payments do not cover the interest due every month, the total amount owed actually increases, rather than decreases.

Significance

Homeowners who owe more on a home than the amount it currently appraises for might find their options limited when they want to refinance. Being underwater is particularly significant for option ARM mortgage holders who want to swap the variable-rate loan out for a fixed-rate mortgage before monthly payments rise. They might find themselves trapped--unable to afford drastic payment increases when loan rates reset, and unable to refinance if banks refuse to deal with underwater owners. Generally, lenders will not refinance mortgages on which the amount owed, compared to the home value, exceeds 80 percent.

Possible Solutions

Homeowners can attempt to renegotiate the terms, payments or principal owed on an underwater mortgage. Lenders differ in willingness to adjust existing loans, and usually the homeowner must be late in making monthly payments for the bank to even listen. Those homeowners who have some extra cash on hand can try to negotiate a cash-in refinance. They put money into a transaction, bringing down the percentage owed on a home in exchange for a fixed rate or lower interest-rate loan. When job changes force a homeowner to relocate, she can either rent out the property or attempt a short sale. A short sale is a transaction in which the lender allows the homeowner to sell a property for less than she owes on it. Financially stable homeowners who owe more on the house than it is currently worth can also choose to keep living in the home and ignore the cyclical housing market.

Deed-in-Lieu/Last Resort

Those homeowners who cannot refinance, cannot make payments and have not been able to sell can write to the lender and request a deed-in lieu of foreclosure transaction (DIL). The distressed homeowner gives up ownership of the property to the lender, and in exchange, the lender then releases the borrower from the mortgage contract and further liability. Deed-in-lieu agreements get the homeowner out from payments quickly, and with less damage to credit scores than foreclosure causes. Because homeowners must promise to maintain a property in a DIL transaction, the lenders avoid the headache of damaged or gutted properties common in foreclosures. Although being underwater makes DIL agreements unpalatable for lenders, sometimes they agree to them in order to avoid foreclosure proceedings.

Misconceptions

Some underwater homeowners fixate on lower home prices and fear that home values will never go up, but real estate markets tend to be cyclical; staying put might be less costly than selling short and moving out. Frustrated owners who consider just walking away from an underwater property need to research potential long-term legal and credit repercussions from doing so.

About the Author

Barrett Barlowe is an award-winning writer and artist specializing in fitness, health, real estate, fine arts, and home and gardening. She is a former professional cook as well as a digital and traditional artist with many major film credits. Barlowe holds a Bachelor of Arts in English and French and a Master of Fine Arts in film animation.

Photo Credits

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